I don’t know why, but all I hear around tax time is “Let’s buy this or that because we need more write-offs!” This is a tactful strategy for decreasing your tax liability while acquiring something you need, but those purchases should not be made frivolously. Spending leftover money at the end of the year should NOT be your main goal. Much like the interest tax shield, write-offs aren’t all they’re cracked up to be. Let me explain why.
Only Buy What you Need
Expenses typically referred to in the small business community as “write-offs”, are purchases made to offset the tax liability that will be incurred after the end of the fiscal year. In other words, you have money left over and you may think you need to spend it so that you don’t pay a seemingly large amount of taxes. This tactic should only be used to buy things that would have been purchased normally or items that you will need to purchase within the next year. If you buy frivolous things, then you are just wasting money to avoid paying the tax on those leftover dollars.
Nobody Likes Taxes
I don’t know a single soul who loves to pay taxes, but you may want to. I’ll clarify this in the next section. Let me clarify why with a brief on taxes. Taxes are charged on a business’ net income. This is the total Revenues minus Expenses, Depreciation, and Interest. Let’s say you have a net income of $100,000 after you’ve paid yourself the wage you deserve. If you’re taxed as a partnership or sole proprietorship (includes S-Corps and LLCs) then the taxes you pay are based on the personal income tax rates. Therefore, your total tax liability includes what you’ve paid yourself and what the company still has in net income.
So if you’ve paid yourself $100k and the business has $100k in net income, then you are taxed as if you made $200k. I think this is mostly a perception issue because you will receive a fairly high tax bill. You don’t notice it as much when you pay yourself because taxes come out of every paycheck, but money that hasn’t been distributed yet will not have had taxes taken out of it resulting in seeing the full tax liability amount in one big chunk.
Build Your War Chest
The world is full of opportunities and if you’re constantly spending everything you have to avoid taxes, then you will miss out. If you had a war chest built up before the economic downturn of 2008, how different would things be for you today? Saving money is tough to do since you end up giving 25% to 35% of everything you save to Uncle Sam, but that’s just the cost of doing business. It’s the cost of living in America. Check out this post on “How to Set Up Your Small Business War Chest” if you’d like to learn more.
I hope that I have clarified some things for you regarding the interest tax shield and write-offs. Build you strategy to start that war chest today and remember to “Stop Doing the Mundane, and Start Getting Weird!”